Regulating Environmental Externalities through Public Firms: A Differential Game^*

We investigate the possibility of using public firms to regulate polluting emissions in a Cournot oligopoly where production generates pollution and public firms are less efficient than private ones. In a differential game we compare (i) the Markov-Perfect Nash equilibrium under social planning; (ii) the Markov Perfect Nash equilibrium in a mixed setup where public firms coexist with profit-seeking agents; (iii) the Cournot-Nash game among profit-seeking firms. In a mixed market, profit-seeking firms internalize the externality generated by production, and social welfare is the highest. We conclude that the creation of a mixed market can be desirable for the regulation of environmental externalities.